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Basic PointsGoodbye, Global Savings Glut:Hello, Food & Fuel Infation
June / July Issue
July 3, 2008
Produced by BMO Financial Group
Distributed by BMO Capital Markets
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Basic Points
An Investment Journal
Donald G. M. Coxe
Global Portolio Strategist, BMO Financial Group
(312) 461-5365
e-mail: [email protected]
Research/Editing Angela Trudeaue-mail: [email protected]
Production/ Anna Goduco (print orders and mailing lists)Distribution e-mail: [email protected]
Goodbye, Global Savings Glut: Hello, Food & Fuel Infation
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1June/July
Overview
We have been bearish about the US stock market since American banking
and nancial stocks broke down last summer. A major nancial crisis hit
Wall Street, and the allout spread across much o the rest o the world like
volcanic ash.
Yet Wall Street remained bullish, climbing briefy to a new high.
Then oil ran past $100 a barrel and kept on climbing.
Then a global ood crisis was proclaimed, and talk o stagfation was heard,
and stocks sulked. But, with the arrival o Spring, Wall Streets animal spirits
came out o hibernation: in early May the Dow was back to 13,000 amid
renewed optimism that the banking crisis was over, and Washingtons
handouts revived consumer spending.
Since then, the hoary strategy o Sell in May and go away has been the new
wisdom.
As the three shocks to the global economyood, uels and olly (o
bankers)work their way into economic projections, the likelihood o the
biggest challenge o alla recessionkeeps increasing, with the US and
Europe looking most vulnerable, and Emerging Markets shares plunging.
For the First Hal, investors ollowing our Bad News recommended
strategies have had excellent relative returns: the CRB Index was up 30.4%
(its largest leap or that period on record) and the S&P and the MSCI worldequity index were down 12%.
We believe that the onset o a global ood crisis at a time o record oil prices
is a direct challenge to the prevalent views o economic growth and infation.
We also grow more concerned by the week about the potential or even
higher prices or oods and uels because o global chills arising rom the
worrisome ailure o sunspots to return ater their normal year o sharply
reduced activity.
We are raising our Cash commitment slightly, reducing bond durations, and
ne-tuning our Recommended Commodity Stock Weightings to refect the
shiting risks and rewards in the raw materials sector.
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Recommended Asset Allocation
Allocations Change
US Equities 21 -5
Foreign Equities
European Equities 7 unch
Japanese and Korean Equities 5 unch
Canadian and Australian Equities 8 unch
Emerging Markets 11 unch
Bonds
US Bonds 7 unch
Canadian Bonds 4 unchInternational Bonds 11 unch
Long-Term Infation Hedged Bonds 10 unch
Cash 16 +5
Years Change
US 4.00 -0.50
Canada 4.25 -0.50
International 3.75 -0.50
Recommended Asset Allocation
(or U.S. Pension Funds)
Bond Durations
Change
Agriculture 35% +4
Energy 29% -2
Precious Metals 25% unchBase Metals & Steel 11% -2
Global Exposure to Commodity Stocks
We recommend these sector weightings to all clientsor commodity exposurewhether in pure commodity
stock portolios or as the commodity component oequity and balanced unds.
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Goodbye, Global Savings Glut:Hello, Food & Fuel Infation
1. The Global Financial Crisis
Until last month, a ortnight rarely passed without some prominent person
proclaiming that the worst o the housing crisis was behind us. However, in
June, what was bustin out all over was pessimism that the worst o the housing
bust was yet to come, as considerations o the impact o trillions in mortgage
rate upward resets came back to haunt policymakers and investors:
...in June, what was
bustin out all over
was pessimism...
Merrill Lynch (MER NYSE)June 2007 to June 2008
20
30
40
50
60
70
80
90
100
Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08
Bank Stock Index (BKX) vs. Mortgage Finance Index (MFX)
June 2007 to June 2008
-75%
-65%
-55%
-45%
-35%
-25%
-15%
-5%
5%
Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08Bank Stock Index (BKX) Mortgage Finance Index (MFX)
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4 June/July
Surprisingly, the nancial crisis did not send Wall Street into an ocially
certied bear marketa 20% decline. The S&P was amazingly calm even
when the Merrill Lynch bull publicly suered the pain and indignity o
sudden steerdom, while its ormer CEO was luxuriating in a settlement that
might have aroused the envy o the Queen o Sheba. (Among the gits she
gave Solomon were gold, spices and perumes. Merrill gave Mr. ONeal real
money, keeping the perumed paper that he had helped to create: presumably,
much o what it couldnt sell has since then gone to the Fed in return or
Treasurys.)
How bad is the banking crisis?
Blackstone (BX NYSE)June 2007 to June 2008
10
15
20
25
30
35
40
Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08
Dow Jones Industrial Average
June 2007 to June 2008
11,000
11,500
12,000
12,500
13,000
13,500
14,000
14,500
Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08
The S&P was amazingly
calm even when the
Merrill Lynch bull
publicly suered the
pain and indignity o
sudden steerdom...
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The Street has a variety o nancial distress measures, most o which rely on
the pricing o derivatives that didnt exist in earlier bear markets. We are told
that the outstanding principal amount o such sophisticated innovations
exceeds $60 trillion. How can we actor such a number into our calculations
o market risk? Like the number o stars, it is beyond comprehension.
A year ago, Tom Wole, the author oBonfre o the Vanities, had been strolling
around the foor o the NYSE. Blackstone was minutes away rom going
public, the largest IPO since 2002, and the Dow was at 13,337. He was asked
by a CNBC reporter what he thought o all the excitement. Wole replied,
We may be witnessing the end o capitalism as we know it.
Last week, Andrew Sorkin oThe New York Times asked him to update his
observations. Wole told Sorkin, It sounds like even the rms that arentin trouble are in trouble. He explained his concerns by citing Schumpeter.
Stocks and bonds are what he called evaporated property. People completely
lose touch o the underlying assets. Its all paperthese esoteric devices. So
it has become evaporated property squared. I call it evaporated property
cubed. But, with his customary politeness, he said, O course, Im not an
economist.
We wrote at the time o Woles visit to the foor that the Streets mania was a
modern replay o the Tower o Babel. We predicted that, like the attempt to
erect a structure that would challenge Heaven, the CDOs and CDSs would
begin to turn to dustsooner or later.
Investors have since learned that we are living dangerously: any nancial
convulsion that evaporates Bear Stearns and costs UBSthe biggest o the
supposedly inscrutable and cautious Swiss Banks$25 billion in writedowns
is no mere hiccup or belch.
Its all paperthese
esoteric devices...
I call it evaporated
property cubed.
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6 June/July
Like Mr. Wole, we arent economists, so we have taken to measuring this
bears erocity by watching what The Greatest Insider is doing to prevent it
rom despoiling the nancial system. Clearly, the stalwarts in the re and
rescue brigade o Bernanke & Co. are alarmed.
U. S. Federal ReserveAdjusted Monetary Base
August 2007 to April 2008
Source: June 26, 2008, Weekly U.S. Financial Data, Research Division, Federal Reserve Bank of St. Louis
06/20/07 09/12/07 11/21/07 12/19/07 01/16/08 02/13/08 03/26/08 04/23/08
11/21/07 1.2
12/19/07 -0.2 -1.1
01/16/08 0.0 -0.5 -3.2
02/13/08 1.0 1.1 0.6 5.0
03/26/08 1.5 1.8 1.9 4.8 6.2
04/23/08 0.6 0.5 0.0 1.8 2.0 -0.6
05/21/08 0.9 0.9 0.6 2.2 2.4 0.6 -2.3
06/18/08 1.4 1.6 1.6 3.1 3.4 2.2 1.0 5.9
Compounded annual rates of change, average of two maintenance periods ending:To the average of
two maintenance
periods ending:
U. S. Federal Reserve
Adjusted Monetary BaseAverages o Daily Figures, Seasonally Adjusted
April 2007 to June 2008
Source: June 26, 2008, Weekly U.S. Financial Data, Research Division, Federal Reserve Bank of St. Louis
2007 2008
Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun
Billions of dollars
845
850
855
860
865
870
Clearly, the stalwarts
in the re and rescue
brigade o Bernanke
& Co. are alarmed.
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For those whove orgotten how the Monetary Base works, a ew pointers:
This is, essentially, the Feds Balance Sheet, and its ordinarily made up o (1)
Securities, including T-Bills, Treasurys, paper rom Federal Agenciesmostly
Fannie Mae, Freddie Mac, Federal Housing Authority and Tennessee Valley
Authority; and (2) Reserves, being deposits o cash made with the Fed by
commercial banks that are members o the system. Banks that are short ocash, borrow rom other banks that have excess reserves; the interest rate on
those loans is the ed unds rateprobably the best-known interest rate in
the world.
Monetary policy operates through the Monetary Base like some great
accordion: it goes out and in. When it is going out, liquidity expands, sending
beautiul dance music to the markets. When it comes in, the sound shits to
a dirge in a minor key.
When the Fed grows its balance sheet aster than the growth o real GDP, that
ordinarily means that the excess liquidity reduces interest rates. Whenas inthe past yearits growth rate is well below the growth rate o nominal GDP,
that is historically a sign o Fed tightening, and is associated with inverted
yield curves and rising interest rates.
Not this time. Interest rates fell 325 bps, despite tiny growth (1.4%) in the fed
funds rate.
The Bernanke Fed has had to throw caution to the winds because too many
major US banks threw caution to the winds years ago.
U. S. Federal Reserve
Reserve Bank Credit and Federal Reserve Holdings o U.S. Treasury Securities
Averages o Daily Figures
Source: June 26, 2008, Weekly U.S. Financial Data, Research Division, Federal Reserve Bank of St.Louis
2007 2008
Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun
Billions of dollars
Reserve Bank Credit
U.S. Treasury Securities
450
500
550
600
650
700
750
800
850
900
The Bernanke Fed has
had to throw caution
to the winds...
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Consider the uniqueness o this convulsion:
1. The Feds balance sheet has barely grown in a year.2. The bank reserve component o the Feds balance sheet is Net Borrowed,
and has been that way or many weeks. Historically, this has also been a
rare event, and a sign o tight monetary policies and a Fed-induced squeeze
on the banking system.
3. Not only is the Fed notsqueezing the banking system, it is showering
the banks with its own most precious assetliquidityin the orm o
Treasurys and T-Bills. Historically, such massive dumping o Treasurys
would have triggered skyrocketing interest rates.
4. For the rst time ever, the Fed isnt dumping Treasurys or cash or againstpledges o Treasurys and other government-related paperit is lending
them out, secured (insecurely) by the same illiquid, dubious or outright
toxic structured products that the banks created in their own Frankennance
labs based on mathematics and risk ormulas that Nassim Taleb (Black
Swan) has long ridiculed as spurious. The banks prospered mightily by
selling these smelly spawn to greater ools, but then they ran out o greater
ools and so the banks were orced to keep these ast-rotting wonders on
their own ast-eroding balance sheets. That meant levering up bank balance
sheets and creating Enronesque o-balance sheet vehicles designed to
borrow short and ingest the longest and most loathsome paper that thebanks couldnt sell elsewhere. Somewhere, the ghost o Enrons Ken Lay,
who died suddenly just beore he was headed or prison, is shaking his
head. As he doubtless ponders, whats the dierence between what we
did and what they did? And why are those ex-CEOs rich and on the most
exclusive o gol courses when I was sentenced so harshly?
5. The banking crisis has backed the Fed into a corner in which ear o
nancial collapse drives away ears o infation. Beore the banking crisis
took center stage, Bernanke mused aloud rom time to time about the risk
to the Feds credibility in using Core Infation as its reerence i Nominal
CPI were staying signicantly higher. (Core Infation has routinely beendismissed by skeptics as The measure or economists who neither eat
nor heat, or by a dry British economist as The measure appropriate or
anorexic pedestrians.) Bernankes 2% ed unds rate is less than hal the
CPI, and is now well below even Core Infation. Central banks who keep
their target rates in negative real terms invite serious infation. Bernanke,
a cautious student o monetary history, would hardly take that risk i he
werent so terried by the allout rom the banking disaster.
The banking crisis has
backed the Fed into a
corner in which ear
o nancial collapse
drives away ears o
infation.
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The crisis could be moving into uncharted territory. Last week, the latest rally
in the dollar that would, the Streets brightest brayed, burst the commodity
bubble, ended suddenly. Commodities rallied, led by the grains. Most
ominously or Bernanke, gold broke out o its correction pattern:
Gold
June 2007 to June 2008
600
650
700
750
800
850
900
950
1000
1050
Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08
US Dollar Index (DXY)
June 2007 to June 2008
70
75
80
85
Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08
How could so many big banks simultaneously behave so stupidly?
Perhaps, because they had diminished quantities o brain power at a time the
global liquidity glut had given them nearly unlimited opportunities to leverup their balance sheets. Their business models were no longer the stodgy,
traditional Basel I banks, but the new stars o Wall Streetthe hedge unds.
How could so many big
banks simultaneously
behave so stupidly?
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During this decade, the number o operating hedge unds increased by more
than 500%. Hedge unds tended to have balance sheets levered even more
heavily than the banks, but they have shown they are able to escape collapse
and earn prots by being collectively smarter than the banks. More banks
have publicly reported horrendous results than have hedge undsand there
are thousands more hedge unds than banks. These shadow banks have
collectively demonstrated their smarts at analyzing the Streets endishly
dicult products and picking out the diamonds in the dung. (Warren Buett
has said it takes 700,000 calculations to value just one mortgage-backed
CDO.)
The sudden appearance o so many geniuses may have been the greatest
instant success story since Jason sowed the elds with dragons teeth and
hundreds o warriors sprang orth.
Since dragons teeth are in short supply these days, rom whence sprang all
these geniuses?
Mostly rom the banks. The explosive growth o hedge unds was seeded and
irrigated by the brain drain rom the big banks.
By 2006, prime brokerage between investment banks and hedge unds was
a major line o business or Wall Street. It is reasonable to assume that the
basic Darwinism that built the hedge und industry would have meant that
the average hedge und practitioner was much smarter than the averagebanker. Result: a dream situation or hedgies: the bankers at the non-stop
poker table had more money than brains, while the hedgies had more brains
than money.
The banks were collectively let with the hedgies rejectsboth in personnel
on their payrolls and paper silting up on their balance sheets. The term used
by bank analysts to compare the perormance o the CDOs comes rom
oenologyvintages. Each year o mortgage-backed CDOs was a new vintage.
And the younger the vintage, the worse. The very worst vintages o mortgage-
backed paper were those issued during 2006 and early 2007and the banks
who created them ound they couldnt ship them out o their warehouses.The hedge unds werent buying. We now know that the hedgies got the good
wines, leaving the banks only the whine.
The sudden appearance
o so many geniuses
may have been the
greatest instant success
story since Jason sowed
the elds with dragons
teeth and hundreds o
warriors sprang orth.
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That the most recently issued CDOs turned out so disastrously seems counter-
intuitive. Wouldnt the banks have learned rom experience? Instead, on the
evidence, the more experience the banks had with such products, the worse
their judgment about what to buy.
What had happened was that the housing bubble had expanded to its peak.
Amid the renzy, the incentive systems to mortgage lenders and CDO creators
had been hugely corrupted. Result: the smart ormer bankers reused to
invest in the paper issued late in the housing bubble at a time when lending
and appraisal practices had been debauched to the point o Hogarthian
dissipation.
We make these points to buttress our argument that the banking crisis is, at
best, in the ourth inning o a game in which the home team is already downby 40 runsand the beer has run out and the exit doors are sealed.
Bank Stock Index (BKX)
January 2005 to June 2008
55
65
75
85
95
105
115
125
Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08
What Bernanke is doing would not just have shocked Congress in previous
eras, it would have led to the ring o the Fed Chairman. That the Fed is now
taking as security hundreds o billions o ace value o the bottom-o-the-
barrel sludge rom the most notorious asset class in the history o modern
banking is a measure o just how seriously Bernankeand Congress and theAdministrationview this crisis.
...the banking crisis is,
at best, in the ourth
inning o a game in
which the home team
is already down by 40
runsand the beer has
run out and the exit
doors are sealed.
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Moreover, the $40 billion or so that Wall Street managed to hustle rom
Sovereign Wealth Funds in just a ew weeks is not likely to be the model
that saves the banks. Every one o those investors is a substantial loser on
its stake. It is highly improbable that the bank CEOs who jetted to Jeddah
and elsewhere to oer a piece o their banks leveled with investors about
the extent o their likely losses. In their deense, given the quality o their
managements, the banks may not actually have understood how serious
were their losses on subprimes and Alt-As, how much they had at risk in
gasping commercial mortgages and Collateralized Loan Obligations, or how
much they might have to advance under existing guaranteed credit lines to
major customers as the recessionary orces intensied.
The US banking sector, once a source o national pride and a global symbol
o American capitalist pre-eminence, is now a national embarrassment, with
some segments already being declared national disasters.
As this chart rom the Bank o England shows, the Sovereign Wealth Funds,
which lost so heavily when betting on the Streets computer-based risk
appraisals, have learned to ear geeks bearing switly-manuactured nancial
products.
Major Banks Tier 1 Capital Raising by TypeSince September 2007
0
10
20
30
40
50
60
70
80
90
100
Hybrid securities(a)Sovereign wealth funds
Rights issue
US$ billions
2007 Q3 2007 Q4 2008 Q1 2008 Q2
Sources: Dealogic, company releases and Bank calculations;Bank of England Quarterly Bulletin, 2008 Q2 Volume 48 No. 2(a) Fixed-rate debt instruments with equity-like features.
...the Sovereign Wealth
Funds... have learned
to ear geeks bearing
switly-manuactured
nancial products.
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Although we discuss this crisis with reerence to the big-cap Wall Street
names, the disease is more widespread:
National City (NCC NYSE)January 2005 to June 2008
0
5
10
15
20
25
30
35
40
45
Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08
Fith Third Bank (FITB NYSE)
January 2005 to June 2008
0
10
20
30
40
50
60
Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08
Washington Mutual (WAMU NYSE)
January 2005 to June 2008
0
5
10
15
20
25
30
35
40
45
50
Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08
...the disease is
more widespread...
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Each o these institutions has a long and proud history. Two are Northeast
Regionals, WAMU is a national S&L, and Suntrust is one o the great names in
the Southeastuntil recently one o the most attractive regions or nancial
institutions. Yet these charts are o the kind that we call, I ound at the end
o a hospital bed, order fowers or the widow.
House prices continue to decline, and, in recent months, the rate o decline
has accelerated. Congress, which boasts such fickering luminaries as
Republican Senator Shelby who has extensive banking connections, and
several high-prole Democratic Senators who have suspiciously avorable
mortgage deals with olks such as Angelo Mozilo o Countrywide Financial,
is getting into housing in a big way. It has expanded the lending power o the
Federal Housing Administration so rapidly and egregiously that the storied
and sae FHA is likely to join the disreputable and nancially risky Fannie
and Freddie as potential supplicants or taxpayer support.
In other words, the US nancial system is in its worst mess since the
Depression.
The consolationi that be le mot juste, is that so is Britainsand, or that
matter, the Swiss and Spanish banking systems. We can remember how
smug the American and British bankers were when the Japanese bankingsystem had become the preserve o the aged, the weak, the hopeless, and the
zombies.
Suntrust (STI NYSE)
January 2005 to June 2008
30
40
50
60
70
80
90
100
Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08
In other words, the
US nancial system
is in its worst mess
since the Depression.
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But the Japanese eventually cleaned up their banking system. In retrospect,
the right trade in this decade would have been to short American and British
banks and buy Japanese banks.
Who would ever have predicted that Bank o America stock would trade at a
10% yield? The B o A was, or years, the pre-eminent total return investment
among nancial stocks. At the time we were writing our book (The New Reality
o Wall Street, McGraw Hill, 2003), we were advising investors that B o A was
the model or a retirement investmentand better than a Treasury bond,
because its dividends would climb every yearand was the most obvious
Great Dividend-Paying Stock. In particular, this was the only large bank that
had zero exposure to Eurodollar deposits: it was entirely unded on domestic
deposits, mostly retail checking and savings accounts. That deposit base was
generally reliable during banking crises, whereas wholesale Eurodollar CDs
were prone to mass migrations i ear were coursing through the system. That
unding base meant the bank was, we argued, almost immune to banking
crises. We were disappointed to learn a ew months ago that the bank had
quietly changed its nancial structure and was now getting an undisclosed
level o unding through wholesale Eurodollar deposits. That bad news came
ater the bank shocked us by buying Countrywide Financial, which to us had
a morally inerior culture to the B o A.
I this powerhouse is so humbled, why should investors have condence in
the merits o lesser organizations?
We are not predicting that dozens more major American and British
institutions must go bust. That said, we wonder how long Bernanke can
continue to rantically disgorge Treasurys in exchange or unmarketable,
undeodorized securities. At his current rate o bailing, the Fed could be
out o Treasurys by year-end, and its balance sheet would be as dubious as
Citigroups. At that point, would he be orced to petition Congress to let
him start selling the gold in Fort Knox? And which Sovereign Wealth Funds
would step orward to displace the Fed as Banker to the World?
We are suggesting that these walking wounded whose injuries were almost
entirely sel-inficted are hardly the kind o deep-pocketed backers who can
haul the American and British economies out o their housing-led unks.
Drunks make bad bartenders.
...the Fed could be
out o Treasurys by
year-end...
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2. The Global Food Crisis
WheatJanuary 2005 to June 2008
200
400
600
800
1000
1200
1400
Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08
Soybeans
January 2005 to June 2008
4
6
8
10
12
14
16
18
Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08
CornJanuary 2005 to June 2008
150
250
350
450
550
650
750
Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08
We have been writing
about the attractiveness
o agricultural stocks
since October 2006.
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We have been writing about the attractiveness o agricultural stocks since
October 2006. This year, we have switched our commentary to discuss the
potential catastrophe the world aces as ood prices soar to levels that threaten
the survival o the poorand o many governments.
In June, the UN World Food Commission held an emergency meeting in
Rome to discuss the global ood crisis. Among the more notable attendees
was Zimbabwes Robert Mugabe, who took time rom waging his typically
vigorous campaign or re-election to make an appearance and appeal or
support or the Commission. Mr. Mugabe was needed because he serves as
Chairman o the UNs Committee on Sustainable Development. He has long
been a leading supporter o the Food Commission, the UNs Program in Iraq
o Oil or Food, Greenpeace, and other similar causes. His shouted reminders
that imperialists and global corporations produce starvation have produced
many a standing ovation in the UN General AssemblyThe Conscience o
Mankind. To make him almost perect by UN and other global standards,
he also opposes genetically modied oods.
In other words, apart rom the way he loots his country, beats up and
murders citizens who disagree with him, and the 1,000,000% infation he
has unleashed, Mr. Mugabe is representative o the orces standing in the wayo achieving a rational and successul global ood program.
Double-digit ood infation is spreading across the Third World. Until last
week, when China reduced its uel subsidies, ood infation accounted or
roughly 80% o Chinas CPI increase. Food is the prime culprit in Vietnams
25% rate o CPI, and Indias 11%.
Rice
January 2005 to June 2008
3
6
9
12
15
18
21
24
27
Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08
Double-digit ood
infation is spreading
across the Third World.
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What concerns us most is that this 1970s-style ood infation comes ater
two decades o mostly good growing weather across the worldincluding
17 consecutive good years in the US Midwest, the sel-styled Saudi Arabia
o Corn. Yet world supplies o grains have declined or six straight years
and are now at record-low levels in relation to consumption. (See the USDA
tables appended to this report.)
Moreover, the ethanol and biodiesel industries in the US and Europe continue
to receive enormous government aid in the orm o taris and subsidies.
These programs were conceived when corn and soybeans were cheap, and
almost no one believed they would ever reach $5 and $10, respectivelylet
alone $7 and $15. Worse: the planners assumed perpetually low prices or
natural gas, the uel in the actories. (Natural gas consumed in ethanol plants
accounted or 6.58.0% o total US gas consumption in 2006.)
Estimates o corn consumption in ethanol plants this year are in the one-third
range. But President Bushs 2007 State o the Union speech called or biouel
production to rise rom 5 billion gallons in 2007 to 35 billion gallons in
2017. (That would include vast expansion o ethanol, plus the prospects or
cellulosic and animal at-based products.)
Peter Brabeck-Letmathe, Chairman and ormer CEO o Nestle, published a
powerul and disturbing op-ed piece in The Wall Street Journal last month.
We have been criticizing the corn ethanol programs with such ervor that
we thought we were among the strongest opponents. In comparison with
Mr. Brabeck-Letmathe, we are wimps. He says, Biouels are economical
nonsense, ecologically useless and ethically indeensibleThe biouel craze,
egged on by global warming activists, has helped uel a huge agricultural
crisis.
However, his indignation hasnt the re power to stand up to the well-
organized sel-interest o the ethanol industry. ADM and riends arent about
to abandon their operations because o the impact on poor people in nations
o which they know little. The counterattack is remarkably sophisticated.
Consider the broadside on speculators and oil delivered to Congress by thenow-amous Michael Masters. (We discuss his arguments about the eects o
pension unds on oil prices on page 25.)
Biouels are
economical nonsense,
ecologically useless
and ethically
indeensible"
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We had heard o his rage at pension unds holding oil utures, but were
rather surprised to read in his screed that the pension unds were also guilty
o inficting starvation on the poor o the world and were alsely blaming the
ethanol industry.
The man Senator McCaskill (D.-Mo.) calls the most important man in
Washington right now was telling Senator Lieberman and other villain
seekers what they wanted to hear.
When somebody who makes a living in the competitive world o hedge
unds makes the breathtaking allegation that the industry that will this year
burn up roughly one-third o the nations corn production has nothing to
do with $7 corn because the pension und speculators drove the price to that
level with their greed, then one wonders about his motivations.
Mr. Masters got help rom another unlikely source. Merrill Lynch published
an analysis that showed that corn ethanol had cut $21 o the price o a
barrel o oil in the Midwest in terms o the cost o gasoline in that part o the
country.
We worry that so much o this debate proceeds on the assumption that the
splendid weather we have experienced or decades will last orever. However,
we have been unable to build up surplus stocks o corn and other grains
despite the best winning streak or Midwest weather on record.
That may be about to end.
As we have been mentioning in this journal in recent months, we are
concerned that the 26 years o very avorable sunspot activity that contributed
so strongly to great growing conditions may be history.
We mention this with some trepidation, because we know what an unusual
idea this is. Moreover, we stuck our necks out last year by raising alarms
about honey bees and there are still bees around and no ood crisis has
resulted. However, the latest statistics on US bees are that the nation lost 31%
o its population during the all and winter o 200607 and a urther 36% a
year later. There is still disagreement about what causes the Colony CollapseDisorder. The risk is still thereand still growing.
...one wonders about
his motivations.
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And so to sunspots.
Here is what we have been talking and writing about. The chart showssunspot activity or the years that astronomers have been recording their
observations:
Sunspot Cycles1760 to 2008
1750 1760 1770 1780 1790 1800 1810 1820 1830 1840 1850
DATE
0
100
200
300
SUNS
POTNUMBER
1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950
DATE
0
100
200
300
SUNSPOTNUMBER
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
DATE
0
100
200
300
SU
NSPOTNUMBER
Source: http://solarscience.msfc.nasa.gov/SunspotCycle.shtml
...so much o this
debate proceeds on
the assumption that
the splendid weather
we have experienced
or decades will last
orever.
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A ew non-controversial notes:
1. Sunspots were rst identied by scientists in ancient Greece and medievalChina. However, it was Galileo who really launched the study o these
solar explosions. Various websites publish the charts showing sunspot
activity over the past 240 years.
2. Historically, years o high sunspot activity have been associated with warm
weatherat least in Europe and North America, where we have detailed
records. Conversely, years o very low sunspot activity have been associated
with very cold weatherat least in Europe and North America.
3. The mini-Ice Age that ended in the early 19th Century was a period o very
low sunspot activity. The Thames requently roze over. In the winter o
1780, one could walk rom Manhattan to Staten Island. Crop ailures due
to early rosts were requent occurrences.
4. The modern sunspot cycle11 yearsbegan in the early 19th Century.
2007 was the nal year o Cycle #23 and was supposed to be the start o
Cycle #24. In each such cycle, sunspot activity moves rom low to high
over 10 years, then drops sharply in the eleventh year.
5. Sunspots may be accompanied by solar fares, in which case the total
radiation emitted can be disabling to communications on this planet.
The massive power ailure or Hydro Quebec in 1989 was caused by such
an event.
6. The last two sunspot cycles had one o the highest sustained levels o
activity on record. Apart rom the eects o Mt. Pinatubo in 1991, the
world experienced pronounced warming during that period. The winter o
200607, the end o the cycle, had very low sunspot activity and the global
temperature ell 0.7C, wiping out the warming o the previous two decades.
The polar ice cap is, according to some reports, back to normal.
7. The sunspots have not returned on schedule. Indeed, there have been many
weeks o zero sunspot activity. Weather in most parts o Canada, the US,
China, Ukraine ,and central and northern Europe has been unusually coldand wet. The jet stream is much urther south than usual or this time o the
year, and that means wet, stormy weather or the Midwest as cool weather
meets the hot, humid air coming north rom the Gul o Mexico.
In the winter o 1780,
one could walk
rom Manhattan to
Staten Island.
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8. According to National Geographic (July 2004), scientists are unsure
about the extent o the relationship between sunspots and weather on
earth. NASA scientists believe that sunspots accounted or up to hal o
global warming until 1940, but believe greenhouse gases have probably
accounted or a greater share o warming since then.
9. I the requency o sunspots does not revert to the pattern o previous
cycles, it would be reasonable to assume that next winter would be bitterly
cold and longat least by recent standards. It would also be reasonable
to expect early rosts in many regions.
What about global warming?
It has been a reality in recent decades, but the dispute among scientists is
about how much o that temperature change is due to human activity and
how much is due to an increase in total radiation received rom the sun.
We arent about to get into that debate, but we believe clients should realize
that, at least in the shorter term, sunspot activity or inactivity is likely to
be a ar greater contributor to global temperature change than those widely
publicized threats to the planetSUVs and bovine fatulence.
I next winter is as cold in China and North America as last winter, and
i spring is as wet in those regions as this year, the eect on global ood
prices would be dramatic. We no longer have any carryover cushion o grains
against severe cold, or against sustained rains on the plains. We believe theglobal warmists may be overstating the eects o human energy consumption
and underrating the eects o changes in the suns radiation, and in ocean
currents. Protagoras amous assertion Man is the measure o all things
became a good slogan or Renaissance philosophers, but may be an unsound
basis or climatology.
Man is the measure
o all things became
a good slogan
or Renaissance
philosophers, but
may be an unsound
basis or climatology.
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3. The Oil Shock
Crude Oil Futures (Dec. 2016 Contract)November 2007 to June 2008
75
85
95
105
115
125
135
145
155
Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08
Crude Oil SpotJanuary 2007 to June 2008
40
60
80
100
120
140
Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08
We dont use the expression energy crisis, because $140 oil isnt a crisisit is
a shock that has varying impact on nearly all sectors o the global economy.
In a sense, there isnt even an oil shortage. It depends what is meant by
oil. Nigerian Bonny Light, the reners dream uel, is not available at its
stated production rate, because terrorists attacking oshore installations
have orced cutbacks amounting to a million barrels a day. Light, sweetcrudethe kind deliverable under WTI or Brent contractsis availableat
a price. Heavy, high-sulur crude is in oversupply: Iran has millions o
barrels available or immediate delivery, but buyers are ew. And, i the
more venomous o the oil-hating NGOs get their way, oil rom Canadas
oil sands will either be choked o at the minesite (or wellhead), or banned
$140 oil isnt a crisis...
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rom entry into the USto save the world rom global warming. (They have
already inserted a provision in a bill that that orbids the Pentagon rom
buying petroleum products rened rom Canadian oil sands. Barack Obama
wowed the Mayors convention in Miami by pledging hed get the nation o
dirty oil that harms the environment, and his sta have conrmed he was
thinking o Canadian oil sands product. But hes a big backer o subsidies
or US corn ethanol and a big booster o taris to keep out Brazilian sugar-
based ethanol, so hes being consistent.)
Regardless o how this oil squeeze plays out, it will have lasting impact on
nancial markets and on the distribution o nancial wealth. The buildup o
wealth in the Gul states is on a scale unprecedented in world history. Their
SWFs and oreign exchange reserves grow by more than $500 million every
day. These unds have become a major component o global savingsand a
crucial component o total global nancial power. Ironically, SUV users are
contributing to overall global savings at a time o shrinking liquidity. Gul
State SWFs are probably getting $50 to $90 to invest out o each barrel o oil
produced. What is unolding is daily drawsat rising rateson consumers
in the advanced nations in a sustained transer o wealth to relatively new
economies. Never, it can be said, have so many sent so much money each
week to so ew.
Most o the commentary on the worlds most-discussed topic$140 oilis
about its impact on global economic growth and infation.
As speakers at the conerence co-sponsored by the Bank o Canada and the
Haskayne School o Business observed last week, the sky-high oil price could
be a transitory event that is largely sel-correcting, it could be an infationary
shock, or it could mark the onset o a sustained period o much higher
infation. Reerences to 1970s-style stagfation abounded.
There was scant support or the election year witch hunt in Congress: that
pension und speculators are responsible or soaring oil prices. That one
previously obscure hedge und manager could have such impact is a measure
o how desperate lawmakers are to (1) nd another villain than just the oil
companies, and (2) to do something about the issue thats suddenly tops
on voters list o concerns.
Never, it can be said,
have so many sent
so much money each
week to so ew.
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Who is this Michael Masters who has so bedazzled Washington?
As Dennis Gartman, Business Week and some clients have noted, his hedgeund (based in the splendidly tax-ree Virgin Islands) is heavy in airlines and
General Motors. More importantly, his big bets on those companies are through
Call Options. In other words, hes positioned perectlyand perilouslyto
prosper i oil prices should sink suddenly amid a sea change o opinion that
it was all about pension und speculators.
Theres nothing illegal about speaking to ones book. Even the imperious
George Soros has been known to do that. However, this new superstar who has
lit up the halls o Congress with a conspiracy theory-style explanation or the
pricing o the biggest commodity might have convinced any doubters that he
was merely perorming a public service had he included an appendix to hispresentation showing how he and his clients stand to win should Congress
be rushed in to enacting a law that would probably trigger a sharp sello in
oil prices. Although most people weve talked to think that would be a brie
eventand one certied expert says it would be ollowed by a huge rally
that would take oil past $150 because o disorderly market conditionsit
would doubtless be wondrously good or voters appraisal o Congress, and
Congresss appraisal o Mr. Masters.
Since the pension unds dont buy actual oilthey buy near-month contracts
and roll themthey couldnt be responsible or such a huge, sustained
rally. Although the value o their total exposure may seem large to some
Congresspersons, it is (at $240 billion) less than the stated cost o just one
o the mortgage bailout bills that Congress is passing. Moreover, the amount
o new money into the commodity unds this year is less than $50 billion
hardly enough to carry oil to stratospheric levels on its own.
That said, Congress is behaving more reasonably to blame TIAA-Cre and
other big pension unds than arguingas have Senators Barbara Boxer and
Dick Durbinthat the huge compensation packages or oil company
CEOs are behind $4 gas. Even John McCain, who should know better, speaks
demagogically o obscene oil company prots and scolds the industry or
not spending more on alternative uels. Unlike the Democrats, however,
he is in avor o letting the industry begin drilling oshore, where many
billions o barrels likely lurkand he is in avor o building nuclear plants.
Since the pension
unds dont buy
actual oilthey buy
near-month contracts
and roll them
they couldnt be
responsible or such a
huge, sustained rally.
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Although Congress is united in insisting that the US must achieve Energy
Independence, and even George Bush has mouthed that demagogic phrase
at times, the Democrats expect that ethanol and other biouels, plus solar
and wind power will provide the energy needed without any drilling oshore
drilling or in Alaskaor commissioning new nuclear plants.
The Democrats zero tolerance or oshore drilling is based on ears o
oil spills, a concern dating back to the Exxon Valdes breakup, caused by a
captain partial, we learned, to gin. We recalled that tragedy last week when
the Supreme Court nally settled the upward limit o the punitive damages
claim against XOM. (The story on trading foors at the time was, What did
the skipper o the Exxon Valdes say to his rst mate? Answer: No, you idiot,
I said Tanquerayon the rocks!) Since then, the industry has learned a lotabout operating oshore. Katrina, the once-in-two-centuries storm, smashed
right into the heart o the oil and gas operations in the Gul. Although there
was severe damage, and production was slashed or months, there was no
signicant oil spill.
The Chinese, under license rom Cuba, will soon be drilling just o the
Florida Keys. I they make a signicant nd, is it too much to hope that
the next President and Congress will reconsider a policy based in emotion-
driven dogmatism?
One noteworthy aspect o this unexpected leap: or the rst time, oil went toa major new high despite signifcantly decreased consumption in the US.
The world has truly changed.
...oil went to a major
new high despite
signifcantly decreased
consumption in the US.
The world has truly
changed.
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4. Recession in the US and Other OECD Nations
One o the equity bulls arguments has been that a great time to buy stocks
is during a recession.
Well, yes
But timing is more than usually important i the US (and some other OECD
economies) is entering a recession. The time to buy is at the bottom o a
recession, when stock prices are down sharply, and beore monetary eases
magic has begun to show results.
Right now, there is no agreement that the USor any other major
economyhas actually entered recession. All the condence surveys
conducted in the US, Britain and even Germany show that businesses andconsumers are as gloomy as they have been since 1982: and the real yield
on the 10-Year Note was 12% back then. Its a negative 14 bps now. Its like
comparing the Spanish-American War to World War I.
This downturn began with the bursting o the housing bubble. Congress is
doing all it can to prevent house prices rom alling ar enough that a new
class o homebuyers can emerge. On the aordability standard, median prices
in cities nationally are still too expensive or lower middle-class buyers.
Meanwhile, the unwinding o the excesses in commercial real estate have just
begun, which means that the cranes now dotting the landscape in the citieswill soon be as rare as whooping cranes. That means that many high-paid
construction workers will soon be joining the unemployment rolls.
How can one be convinced that the recovery is coming soonas the Fed
assured us in announcing it was leaving rates unchanged?
Here is a particularly bleak chart:
General Motors (GM NYSE)June 2006 to June 2008
10
15
20
25
30
35
40
45
Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08
...the cranes now dotting
the landscape in the
cities will soon be as
rare as whooping cranes.
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GM is back to where it was in 1955, three years ater Engine Charlie Wilson
was alleged to have said, Whats good or General Motors is good or the
country. (What he actually said was, I have always thought that what was
good or the country was good or General Motors.) Al Capp satirized him
as General Bullmoose in the musical Lil Abner, in the song, Whats good or
General Bullmoose is good or the USA.
GM is not just in trouble because o SUVs and other cars: its in trouble because
its nance subsidiary that prospered or so many decades through auto loans
got into mortgage nancing bigand badly. So GM is an encapsulation o
the whole recession/slowdown debate.
We reiterate our view that this was destined to be a very dierent kind o
slowdown, because the Inventory-to-Sales ratio was at an all-time low o1.25 months as o year-end, and because the plunge in the birth rate ater
1971 means that there will be no explosive rise in youth unemployment
traditionally the age cohort most vulnerable to a recession.
But we believe strongly that the three previously discussed interlocking,
overlapping and mutually reinorcing trendsthe nancial crisis, ood and
uel infationmean that the challenge or the Fed and other policymakers
is more daunting than in all previous postwar recessions except 1982.
Furthermore, this is the rst recession in which demographic decline is an
infuenceboth or good and or bad eects. We have already discussed whythe relative paucity o young people seeking work compared with, say, 1974,
is a boon or the economy. However, the percentage o the population that is
young people with jobs who are ready to leave home is a prime demographic
in housing demandand that number is lower than in earlier recessions.
Admittedly, it is better in the US than elsewhere in the OECD because o the
high percentage o Latinos in the 1535 age groups.
...this was destined
to be a very dierent
kind o slowdown...
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Summing up, we remain unsure whether this will unold as a recession
and recovery, or prolonged slowdown and eventual recovery. For many
job categories in the nancial community, its a deep recession. For many
autoworkers, its a deep recession.
But the economists say it doesnt qualiy as a recession.
For investors, we think the prudent course is to treat it as a recession until
proved otherwise. Stay overinvested in commodity stocks whose earnings
and perormance are tied to stronger economies in the Third World, and stay
underinvested in nancial stocks until they start to demonstrate the kind o
strong relative perormance that means its time or the All Clear whistle
to sound.
What about the eect on the economies whose powerul growth has driven
the commodity bull market? As stock markets in China and India conrm,
the rumbustious growth that seemed to blast past all orecasts is easing.
Maintaining ood and uel subsidies at a time when growth in exports to
OECD economies is suering poses huge problems or these and other Third
World powerhouses. However, as the newly negotiated prices or iron ore,
coal and potash conrm, these economies are still much stronger than the
OECDand they still need stu.
...these [Third World
powerhouses] are still
much stronger than the
OECDand they still
need stu.
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INVESTMENT ENVIRONMENT
Milton Friedman told central bankers that their most important task was to
anchor infation expectations at low levels. Once the business community
and consumers concluded infation had nowhere to go but up, then the
behavioral shits would put near-intolerable pressure on the central banks.
Ben Bernanke bravely continues to assert that infation will moderate later
this year and next year. But, as The Wall Street Journal thunders in its lead
editorial on June 26th, According to the Conerence Boards June survey o
consumer sentiment, Americans believe infation over the next 12 months
will be 7.7%. Thats up rom 6.8% in April, 5.4% in February, 5% last
September, and the highest in the last 20 years.As we wrote last month, once commodity infation hits, it is crucial that
central banks crush it beore it works its way into the system. The Fed amously
ailed to do that under Nixon, Ford and Carter, so Paul Volcker had to wrestle
infation to the ground with a powerul bearhug. (The expression wrestle
infation to the ground has been used by various politicians who were not
equipped physically or intellectually to carry out their boast. Volcker was not
only 67, but he had the intellect and wisdom to back up his Brobdingnagian
size. He crushed infation by crushing money growth. He didnt set infation
targetshe set monetary targets, believing, with Friedman, that infation
would only go away when excess monetary growth had become extinct. AterVolcker retired, infation targeting quietly crept back into the policy chambers
at leading central banks. Volcker has publicly condemned infation targeting
recently, without mentioning any central bankers by name.)
We remain o the view that the risks outweigh the rewards or most North
American equity groupsparticularly the banks.
...the risks outweigh
the rewards or most
North American equity
groupsparticularly
the banks.
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Bank o America (BAC NYSE)June 2006 to June 2008
20
25
30
35
40
45
50
55
60
Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08
Citigroup (C NYSE)
June 2006 to June 2008
10
15
20
25
30
35
40
45
50
55
60
Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08
I remember being on CNBC last August and telling the interviewer that
investors should buy the commodity stocks and sell the big banks, such as
Citigroup. She interrupted me to read out a strong Buy recommendation
on Citigroup that had just been issued by some well-known analyst. I was
not given a chance to reply.
I cite that exchange because, even though it was obvious that the nancialsystem was in severe turmoil, the Wall Street elites still looked at the big
banks as core investments and looked down their noses at commodity stocks.
It was hard or them to ace the act that the biggest names in the biggest
nancial corporations had betrayed their stockholders, employees, America,
and the global economy.
Among those who
have been given the
biggest paychecks
and the biggest perks
are men who made
the biggest blunders
in modern banking
history.
A year ago, Bank o America and Citigroup were ranked highly by most bank
analysts. How are the mighty allen:
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Free markets are all about risk and reward. Capitalism is ordinarily the best
o systems because it rewards those who make the biggest contributions to
prots and growth, and punishes those who make bad decisions, or abuse
the system.
Not this time.
Among those who have been given the biggest paychecks and the biggest
perks are men who made the biggest blunders in modern banking history.
Compared to them, Congress looks smart and virtuous.
They have imposed a terrible burden on Bernankeand on the most
vulnerable workers across the American economy. Yes, their stockholders
have suered, but ew regular readers o this publication have lost money
rom the collapse in those stocks. The readership sel-selects: our viewpoint
is so contrarian that only a small minority o investors could stand to work
their way through our prose.
But we are all involved in the travails o an American economy that has been
pushed to the limits by the bad behavior o all those wealthy and powerul
men.
That they are disgraces to capitalism is obvious. That they dont seem to realize
just how appalling their behavior has been is a sign o their moral vacuity.
That they have been paid egregious sums o money and have not once oered
to repay unds which were paid to them based on their misrepresentation o
the actual risks they were assuming and the misstatements o real earnings o
the companies they led shows why they are greater challenges to capitalism
than all the socialist editorialists in the land.
As Friedman wrote: the main challenge to capitalism is capitalists; the main
challenge to socialism is socialism.
Investors should assume that the punishment being administered to the
American nancial system by the market itsel still has a long way to run.
That they are disgraces
to capitalism is
obvious....they are
greater challenges to
capitalism than all the
socialist editorialists in
the land.
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INVESTMENT RECOMMENDATIONS
1. This is a Bear market on Wall Street. Like other bear markets, it is being led
by the Financial stocks. Until they start to outperorm on relative strength,
the markets primary trend is down.
2. Canada went to another new high last week. This year will be the seventh
straight year that Toronto has outperormed New York. At some point,
those Canadian investors who, aficted with the national ineriority
complex, are so eager to sell Canadian stocks to buy the big US names
discussed on CNBC will realize just how expensive their bad habit really
is.
3. One reason or Canadas outperormance is that Canadian bank stockshave been so strong compared to their US counterparts. A decade ago, the
price to book comparisons avored US banks. In recent years, it has been
No Contest. As o last month, (according to the great Hugh Brown), the
ratio avoring Canadian banks over US banks went to a new high. That
means, or Americans, i you must own banks, go North.
4. Gold gives three signals: inverse perormance to the dollar, an infation
call, and a warning i a nancial crisis impends. Gold shot through $1,000
an ounce at the time o the Bear Stearns vaporization: many investors
(including us) thought the Bear was, with Goldman, one o the two well-
managed investment banks, so its demise meant urther collapses. When
Bernanke managed to avert urther crashes, gold retreated to $850. It is
once again signaling that there is stormy weather ahead on Wall Street,
just as there is stormy weather on the plains.
5. That stormy weather across the Midwest keeps destroying crops and sending
grain and soybean prices skyward. Remain overweight the ertilizer, arm
equipment, and seed stocks. They are no longer cheap, but, unlike most
other equity groups, they oer powerul earnings growth storieseven i
the US and Europe go into recessions.
6. Remain overweight the oil and gas stocks. We think the upside potentialor natural gas now exceeds that o oil, which is vulnerable to a downside
correction, particularly i Congress passes a law that orces pension unds
to disinvest in commodities. We still think that is unlikely, because it would
not only be bone-headed, but it would set a terrible precedent, and would
undermine the basic theory underlying ERISA.
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7. The mounting propaganda campaign against the Alberta oil sands could
infict real harm. We do not recommend that clients invest in companies
that are still ar rom production, but do recommend that clients stay
overweight the producers. I the US actually decides to ban imports
o Alberta synthetic oil, then their production will be sent to China.
Americans would then be even more dependent on Venezuela, Nigeria,
and the Gul states.
8. Although the US economy is weak, we do not believe that the US bond
market is attractive. We think the major central banks will be orced to
tighten policy. Canada has already shown that it is leery o urther easing;
the ECB and the Bank o England will soon be tightening. I Bernanke
keeps ocusing on saving Wall Streets Worst, then US infation will climb
aster, and the dollar will sink aster.
9. The economies oering good economic growth and good demographic
growth are all outside the OECD. Most o their stock markets soared last
year and have gone into a unk this year. We worry that ood infation,
coupled with high energy prices, will pose great challenges to some o the
rising stars internationally. In particular, we are concerned about India,
which is most vulnerable among the large economies i severe weather
should trigger $9 corn and wheat. Brazil is the major emerging economy
whose stock market has remained strong, and that actually benets rom
crop ailures abroad.
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USDA Agricultural Outlook
World Supply & Utilization o Major Crops, Livestock, & Products
Source: USDA Economic Research Service, Agricultural Outlook: Statistical Indicators, May 2008: ht tp://www.ers.usda.gov/Publications/AgOutlook/AOTables/
1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09
Mi ion unitsWheat
Area (hectares) 215.7 217.9 215.2 215.2 210.2 217.6 218.8 212.2 217.5 224.9Production (metric tons) 586.7 582.9 583.1 568.7 553.8 625.7 620.8 592.0 606.4 656.0Exports (metric tons) 113.4 101.5 105.7 105.6 108.6 110.8 116.3 110.7 109.6 117.5Consumption (metric tons) 585.0 585.0 587.1 605.2 588.6 606.9 624.2 615.4 620.4 642.0Ending stocks (metric tons) 209.5 207.5 203.4 166.8 132.1 150.8 147.5 124.1 110.0 124.0
Coarse grainsArea (hectares) 299.0 296.1 301.0 293.0 306.9 300.2 301.7 304.5 316.8 313.0Production (metric tons) 878.0 863.0 895.1 875.6 916.3 1,016.1 979.8 982.6 1,067.1 1,070.6Exports (metric tons) 104.9 104.1 102.0 102.1 103.2 100.9 107.1 116.8 125.7 119.3Consumption (metric tons) 882.8 884.5 907.4 903.9 945.3 979.1 993.1 1,012.8 1,067.0 1,078.4Ending stocks (metric tons) 232.5 210.9 198.6 170.3 141.3 178.3 165.0 134.8 135.0 127.2
Rice, milledArea (hectares) 155.3 151.7 150.7 146.0 148.3 150.6 152.7 153.7 154.4 155.7Production (metric tons) 408.9 398.9 399.7 378.1 391.5 400.9 418.2 420.6 427.1 432.0Exports (metric tons) 22.8 24.1 26.9 28.7 27.4 28.5 30.4 30.8 27.0 27.0Consumption (metric tons) 399.8 395.3 413.4 407.8 413.7 408.9 415.6 420.5 424.4 428.0Ending stocks (metric tons) 143.1 146.7 133.0 103.3 81.2 73.2 75.7 75.8 78.5 82.6
Total grainsArea (hectares) 669.9 665.7 666.9 654.2 665.4 668.4 673.2 670.5 688.7 693.6Production (metric tons) 1,873.6 1,844.8 1,877.9 1,822.4 1,861.7 2,042.7 2,018.8 1,995.2 2,100.6 2,158.7Exports (metric tons) 241.1 229.8 234.6 236.4 239.2 240.2 253.8 258.3 262.3 263.8Consumption (metric tons) 1,867.6 1,864.8 1,908.0 1,916.9 1,947.6 1,994.9 2,032.9 2,048.7 2,111.8 2,148.4Ending stocks (metric tons) 585.2 565.1 535.0 440.5 354.5 402.3 388.2 334.7 323.5 333.8
OilseedsCrush (metric tons) 246.2 253.9 264.5 269.9 279.1 302.7 318.4 331.2 341.7 --Production (metric tons) 304.2 313.9 324.9 331.3 335.9 381.5 391.4 408.1 390.8 --Exports (metric tons) 59.2 66.8 62.2 69.6 67.0 74.4 76.0 83.1 88.5 --Ending stocks (metric tons) 38.4 40.0 42.3 48.5 44.7 57.1 64.2 73.0 56.7 --
MealsProduction (metric tons) 167.9 174.7 182.6 186.0 190.4 206.7 216.1 225.8 233.8 --Exports (metric tons) 46.7 48.5 52.8 53.7 58.6 60.4 65.5 68.3 72.7 --
OilsProduction (metric tons) 85.9 89.7 92.7 95.9 102.5 111.4 118.3 122.3 128.5 --Exports (metric tons) 28.7 30.9 33.1 35.8 38.9 42.4 47.1 48.4 51.2 --
CottonArea (hectares) 32.3 32.0 33.7 30.8 32.3 35.7 34.7 34.7 33.6 --Production (bales) 87.9 89.1 98.7 91.0 96.8 121.4 116.6 122.1 120.5 --Exports (bales) 27.2 26.3 29.1 30.3 33.3 35.0 44.6 37.3 38.4 --Consumption (bales) 90.5 90.8 93.6 97.6 97.1 107.4 114.6 121.5 121.9 --Ending stocks (bales) 51.1 49.3 54.7 47.9 48.2 60.6 62.4 63.0 61.6 --
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Beef and PorkProduction (metric tons) 139.2 139.6 141.1 146.0 148.7 152.6 157.3 157.8 156.1 158.0Consumption (metric tons) 139.4 139.3 140.7 145.9 148.8 152.1 156.5 156.8 155.5 157.5Exports (metric tons) 9.1 9.0 9.1 10.2 10.7 11.4 12.3 12.7 12.8 13.1
Broilers and TurkeysProduction (metric tons) 55.1 57.9 60.0 62.3 63.1 64.6 67.8 68.8 72.9 76.0Consumption (metric tons) 54.9 57.4 59.1 61.6 62.5 63.8 67.1 68.5 72.6 75.4Exports (metric tons) 4.8 5.2 6.0 6.2 6.5 6.6 7.4 7.1 7.8 8.3
DairyMilk production (metric tons) 383.0 389.4 394.4 405.3 409.6 415.7 421.4 427.8 435.7 439.6
APPENDIX
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